Markets’ high hopes for low rates

Stocks rallied yesterday with investors still not convinced that a bigger rate cut is off the table for next week’s FOMC meeting. Producer prices support the slowing inflation story keeping the Fed on track for its first rate cut in the Fed’s post-apocalyptic era.

Head clear, eyes forward. As we walk through the valley of speculation (earnings season is over and no more economic numbers before the FOMC meeting), we are left to wonder what the future holds for our stock portfolios. I don’t know about you, but the Fed’s 2022 reactionary assault on inflation and the stock market’s reactionary assault on perfectly healthy stocks is still quite fresh in my mind. This, despite the fact that stocks have done quite well, generally speaking, since the Fed stopped hiking rates. Of course, that was all helped along by investor’s discovery of generative AI and the companies that make AI possible.

It wasn’t just AI excitement that has provided support to the markets. No, it was also the prospect that the Fed would start to lower interest rates at some point. My regular readers know that I, despite being a quantitative-heavy finance guy, like to jest about the importance of interest rates on growth stocks. Sure, I know the equation. And, ya, of course I use it all the time, almost daily, for various things, but telling me that Microsoft is suddenly worth less because some overnight lending rate between banks is now ¼ basis points higher than it was yesterday is, kind of comical. Will it impact next quarter’s earnings? Maybe, but am I making a long-term investment commitment to a company like Microsoft for its next quarter’s earnings? Of course, not; no, I am interested in the company’s future prospects, its pipeline of innovation… the great things to come, and Fed Funds has nothing to do with it. Wow, did I just go on a mini rant 🤪? Ok, I am not recommending that you buy the stock, but simply using a well-known growth company that lost value in 2022 as the Fed began to hike rates and investors justified selling due to the interest rate-sensitive present value equation.

Come to think of it, Microsoft is a good example for this, because when the market’s sudden awareness of generative AI took off in March of 2023, all those interest rate fears went out the window and the stock started to gain altitude even as the Fed continued to hike interest rates. In other words, it became a growth story again... thankfully. All that aside, we are here now, and there is a renewed optimism that stocks will no longer be held back by high interest rates as the Fed prepares to possibly lower them for the first time since 2020.

Yes, indeed! Markets are pricing in at least a -25 basis-point rate cut at next week’s FOMC meeting. In fact, Fed Fund futures are still implying the possibility of a -50 basis-point move. Earlier in the week, that probability was less than 20%, but this morning futures are making the probability of a ½ percentage point cut at 44%. In Wall Street terms, I would say that is possible but not probable; we like things with better than even odds 😉. Still, FOMC members will make their decisions next week, not based on what futures markets are saying, but rather (or at least we hope) based on their assessment of the strength of the economy and the labor market. Overnight WHILE YOU SLEPT, former New York Fed President Bill Dudley said that there was a good case for a -50 basis-point cut next week. He is retired from Fed-ing, but his words still matter, and believe it or not, the market responded to his admission, making it clear that the bulls are counting on lower interest rates to power their next move up.

Regardless of the theory behind it all, we cannot argue that stocks have responded positively to overtures of lower interest rates. So now what? What if the Fed cuts rates, as expected, next week? Better yet, what if the Fed surprises us with a -50 basis-point move? Even better yet, what if the Fed’s statement and guidance imply more aggressive moves going forward? Sure, those are all likely positive for stocks. But there is a catch, my friends. With interest rates no longer an excuse to make investment decisions, stock investors are going to have to fall back on their older playbooks. You know, the one which talks about investing in companies with solid earnings growth, good management, strong balance sheets, and GREAT GROWTH PROSPECTS for the future. I am OK with that scenario because I never changed my playbook in the first place 😉.

YESTERDAY’S MARKETS

NEXT UP

• University of Michigan Sentiment (Sept) may have increased to 68.5 from 67.9. Don’t miss the series’ Inflation Expectations; the Fed watches those as a driver, and those are expected to come in unchanged.
• Next week we will get Retail Sales, housing numbers, regional Fed indicators, Leading Economic Index, and, of course, the long-awaited FOMC meeting and rate decision. It will be a wild week for certain, so check back in on Monday to get calendars and details.

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